Image: Courtney Scott
Erik S. Lesser  /  msnbc.com file
Courtney Scott, who lives in the Atlanta area, is "more confused than ever" after battling for two years to save her home from foreclosure.
By John W. Schoen Senior producer
msnbc.com
updated 1/26/2010 2:00:07 PM ET 2010-01-26T19:00:07

Millions of Americans who are struggling to save their homes from foreclosure are trapped in a labyrinth of disappointment and misinformation created by the very institutions they’ve been told are trying to help them.

Ten months into the government’s third program in two years to stop a record wave of foreclosures, homeowners, housing counselors, consumer advocates and attorneys working with borrowers report that the latest effort is falling far short of its goal. In many cases, lenders are moving to foreclose even after homeowners get approved for loan modification, housing counselors and attorneys say.

The problem, they say, goes beyond the paperwork snafus and staffing shortages at lenders and mortgage servicers that have created massive bottlenecks for the millions at risk of losing their homes. Those have plagued the government’s foreclosure relief efforts since the first government-industry joint program, the Hope Now Alliance, was launched in October 2007.

Homeowners face numerous hurdles trying to get their mortgage modified. In some cases, applications are rejected with little or no explanation. It’s impossible to independently verify if a homeowner qualifies because the Treasury has not disclosed the eligibility formula used by lenders — a complex set of calculations that housing counselors and consumer attorneys have dubbed “the black box.” Housing attorneys report that some lenders are ignoring the program’s guidelines altogether and moving to foreclose without properly reviewing mortgages for possible modification.

“It’s been a stubborn challenge," said a Treasury official, who agreed to an interview but requested anonymity. "But this is something that’s never been done before."

Guidelines ignored
Many of the urgent problems with the government’s $75 billion Home Affordable Modification Program, or HAMP, are systemic. They can be traced to its basic guidelines for lenders and mortgage servicers — the companies tasked with collecting payments from homeowners and forwarding them to the investors holding a homeowner’s mortgage.

Launched last March as part of the Making Home Affordable initiative, HAMP was the Obama administration’s flagship program to halt a wave of foreclosures that two previous government efforts — the Hope Now Alliance and Hope for Homeowners — had failed to slow. In return for signing on to the program, lenders and mortgage servicers who agree to follow standard loan modification guidelines are paid a taxpayer-funded bounty of up to $4,000 for each loan they modify. Homeowners begin with a “trial” modification that is supposed to be made permanent if they keep up with payments for six months.

The HAMP guidelines call on lenders to try to modify every mortgage before moving to foreclosure. But that’s not what’s happening, according to a survey of more than 100 housing attorneys by the National Association of Consumer Advocates.

“Ninety-five percent (of the attorneys surveyed) said that a (mortgage) servicer had attempted to proceed with a foreclosure sale without a proper HAMP review,” said Ellen Taverna, a NACA associate who conducted the survey. Nearly half the housing attorneys said they have represented 10 or more households who had faced a foreclosure without a proper loan review; 14 percent said they have represented 50 or more households in that situation.

So far, the HAMP program hasn’t slowed a record pace of foreclosures. Some 2.8 million households were threatened with foreclosure last year, according to RealtyTrac, a Web site that tracks foreclosure filing nationwide. The company estimates the figure could rise to 3.5 million this year as payments reset on a wave of "pay option" adjustable-rate mortgages, which came with an especially nasty feature called "negative amortization." Simply put, these homeowners face the prospect of a rising mortgage balance - leaving them owing more than they originally borrowed.

Frustrated by the lack of progress with loan modifications, some homeowners are giving up and choosing “strategic default” — simply walking away from their homes. Those defaults, and the ongoing wave of foreclosures, will continue to weigh on the housing market, holding back the nascent economic recovery.

Saving a home from foreclosure can be as simple as rewriting a costly, high-rate subprime loan to prevailing mortgage market rates. If that doesn’t bring the payment to within roughly 31 percent of a homeowners’ monthly income, HAMP guidelines require mortgage servicers to follow a step-by-step process to cut mortgage payments further. First, they can write down the interest rate to as low as 2 percent and then stretch the term of the loan to 40 years. If that doesn’t work, lenders can cut the amount of principal owed.

But cutting principal is entirely voluntary, and most lenders aren’t doing so, housing counselors and attorneys say.

“I don’t think it’s common at all,” said Helene Reynaud, vice president of national grants for the National Foundation for Credit Counseling. “When we ask our counselors, they never seem to see them. Or very, very rarely.”

'More confused than ever'
Even if a homeowner gets a “trial” modification - and makes each new payment on time - they can still lose their home.

“The foreclosure and loan modification proceed on two separate tracks,” said Diane Thompson, an attorney with the National Consumer Law Center, who recently wrote a reporton financial incentives that often encourage mortgage services to foreclose. “If you allow the foreclosure process to continue you’re going to end up with (foreclosure) sales because there’s not good communication between those two divisions in servicers.”

That’s what happened to Courtney Scott, a retired nurse living in an Atlanta suburb, who has spent the last two years trying to get Bank of America to modify her loan.

A week before Christmas, she got a letter saying that her mortgage was going to foreclosure, even though the bank hadn’t reviewed her application for a loan modification. Desperate to save her home, along with her substantial down payment and the equity she’s accumulated by making repairs, Scott says, she spent several hours on the phone trying to get through to bank representatives. When she finally reached them they were unable to find her application.

They told her that she would have resubmit it, which she did.

So she was thrilled when the good news arrived via e-mail Jan. 4.

“Your loan modification has been approved,” the e-mail said, asserting that a full package of documents was in the mail and that a “workout negotiator” would soon be in touch by phone.

“This will be a great end to what has been an unnecessarily drawn-out story,” she told msnbc.com.

But Scott’s joy was short-lived.

On Jan. 12, she got a call from a bank representative who told her that she didn't qualify for a new loan after all. A follow-up email confirmed the bad news.

“I am more confused than ever,” said Scott.

(A Bank of America spokeswoman declined to comment, citing privacy laws, but said she would look into Scott's case.) 

The communications breakdown is more likely when foreclosures are handled by outside attorneys hired by a loan servicer, say housing counselors. If the lender or servicer doesn’t take the extra steps required to stop the clock on a foreclosure proceeding, it can easily overtake the process of modifying a loan, they say.

“The (foreclosure) process carries on a momentum of its own,” said Thompson. “Some of it happens more or less automatically once you start scheduling things. Once a sale is scheduled, someone has to actively intervene to stop the sale, and the current guidance from Treasury allows a (foreclosure) sale to be scheduled even if someone is making current payments on their trial modification.”

The Treasury official said that guideline is under review.

"We certainly hear the issue, and want to make sure the (HAMP) guideline on foreclosure prevents anyone’s home from going to sale," the Treasury official said. "We are looking at guidance to make sure the communication is clear."

The 'Black Box'
Homeowners who have been turned down for a modified mortgage report that servicers often don't spell out why they deny an application, say housing advocates. With no formal appeals process, HAMP makes it extremely difficult for homeowners and their counselors to figure out whether their applications were properly reviewed.

Attempts to contact lenders and servicers often go unheeded, according to Brenda Lopez, chief operating officer at SurePath Financial Solutions, a HUD-approved credit counseling service in Camarillo, Calif.

“They say, ‘I don’t have access to that information,’ and then they transfer you, and then they’ll transfer you again,” she said. “Then they’ll tell you, 'The case is already closed, you cannot reach the negotiator and I don’t have that expertise to tell you why it got denied. It got denied.' And that’s it.”

Late last year, the government "issued instructions for servicers to specify in detail" why a borrower was rejected for the program and to consider other loan mitigation options, the Treasury official said.

Worse, say housing counselors and attorneys, there is no way to independently verify whether a lender or servicer has followed the government’s HAMP guidelines. That’s because the Treasury hasn't disclosed the "black box" formula used to decide which loans will get modified.

Under HAMP guidelines, lenders can deny a loan modification if the “net present value” of the new loan is less than the return they would get from not offering a new loan and going through with foreclosure instead.  In other words, the official guidelines allow mortgage servicers to base their decision entirely on whether the outcome is in the best interest of the lender or investor, not the homeowner.

Because the Treasury has kept the formula a secret, homeowners who have been rejected for modification can't check the lender’s math to correct possible mistakes about the borrower's income, home value, credit score or other critical pieces of data.

“As long as there is secrecy around the formula, and it’s not well understood how it functions, that’s a big issue,” said Reynaud.

In response to requests from housing counselors and attorneys, the Treasury plans to provide more information on the formula by the end of the first quarter, the Treasury official told msnbc.com.

That secret formula also has slowed loan modification negotiations with homeowners because many lenders are apparently unwilling to deviate from the formula, even if the investor holding the mortgage is willing to be more flexible, according to housing counselors.

“Many of the investors are anxious to do a workout that goes beyond the standardized approach that the servicers have scripted,” said David Berenbaum, chief program officer at the National Community Reinvestment Coalition, which oversees a national network of housing counselors. “The servicers blow a gasket when (our counselors) call the investors (directly.) They get very upset with us. But ultimately there's nothing they can do.”

That kind of end run is exactly what happened last week in Scott’s case. While she continues to try to appeal her loan modification rejection with her bank, she said she was surprised by a call from someone representing the investor holding her loan, who said they were offering another chance to modify her mortgage with a slightly lower payment. (Scott is working with a local HUD office to follow up on the offer.)

The number of homeowners who have been helped by the program has been dismally small.

When first announced last year, Treasury officials said they hoped to stop as many as 4 million foreclosures. But HAMP guidelines initially were incomplete, and mortgage servicers complained they weren’t given enough guidance on how they should be applied.

For their part, lenders and loan servicers express their own frustrations with the HAMP program. They note that some homeowners don’t respond to their outreach efforts, fail to properly fill out applications and often submit incomplete paperwork.

They also complain that the HAMP program has been plagued with numerous revisions and delays in issuing technical details attached to broad guidelines. Since April 2009, new program requirements were released nine times, and more than 90 clarifications were issued for new or revised forms, reporting changes and policies, according to the Mortgage Bankers Association. The changes meant mortgage servicers had to alter their procedures and retrain employees, which added to delays.

In July, as the pace of foreclosures continued to rise, major lenders were summoned to a Washington meeting with Treasury officials. There, they committed to modify 500,000 mortgages by Nov. 1.

By the end of December just 66,000 homeowners had been issued permanent loan modifications, with temporary modifications in place for about 850,000 more (who still faced the prospect of having it reversed by the lender.)

The Treasury official said the major focus now is on converting those temporary modifications to permanent loans.

Some banks and lenders have done better than others, according to a recent report by ProPublica, an independent, non-profit newsroom that produces investigative journalism.

“The big names are among the worst-performing servicers,” according to ProPublica. “Bank of America, JPMorgan Chase, CitiMortgage and Wells Fargo together account for more than 60 percent of the 3.4 million mortgages eligible for the program. All four have converted a small percentage of the trials begun three or more months ago into permanent modifications. The highest is Wells Fargo, with only 13 percent."

Some housing counselors think the Treasury needs to get tougher with lenders and loan servicers who don’t follow the guidelines that call for a thorough loan review before moving to foreclosure.

“I don’t think that Treasury has reached the point where they can even enforce their own directives, either because they don’t have the resources or the tools to punish the servicers,“ said Reynaud.

Others say the lack of enforcement is the result of problems with the program itself, starting with the contracts lenders and servicers signed with the Treasury to participate in HAMP.

“In most circumstances, all (Treasury) can do is ban servicers from the program,” said Thompson. “And that’s not a very effective way of getting them to make modifications if they’re not already making them.”

Treasury officials say they expect to make some relatively minor changes this week to HAMP guidelines. But a growing number of stakeholders think broader changes are needed.

Lenders note that, since foreclosures began surging more than two years ago, the primary cause has shifted from rate adjustments to job loss, which leaves homeowners unable to manage even a lower monthly payment.

The MBA wants to see the HAMP program modified to include standard guidelines for loan forbearance, in which lenders temporarily suspend payments until the borrower can find a new job. It also wants to HAMP guidelines expanded to include interest-only loans, which the trade groups says could help more people get an affordable loan.

Others suggest it’s time to revisit a proposal, fiercely opposed by the lending industry, to allow bankruptcy judges to modify mortgages from the bench. (Primary mortgages are currently the only form of debt excluded from so called “judicial modification.”) Housing advocates say changing the bankruptcy law would dramatically speed the pace of loan modifications and save millions of homes from foreclosure.

“There are many people in the industry who would be glad to see HAMP go or who don’t believe that these modifications can work,” said Thompson. “Most people who are representing consumers think that there are there are significant flaws in the program’s design, but that some kind of government-sponsored modification program is essential to get us out of the foreclosure crisis.”

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